The Terrifying Truth About Your 401(k) Plan

Halloween is the time for costumes, candy and haunted houses. 401(k) plans are often dressed up in scary costumes with hidden fess in complex investment arrangements. Be smart and don’t let your plan provider steal all your retirement candy.

A frequent disguise of 401(k) plans is offering the same investment option at varying costs. While the underlying holdings of each investment are identical, an investor’s performance will vary based on the expense ratios of each individual share class.

Many record-keepers like American Funds and Fidelity have a range of share classes for different plans. The more expensive share classes often include additional 12b-1 fees along with complex revenue sharing arrangements.

This would be like the Walgreens next to your house charging $15 for candy while the one across town sells the same bag for $10.

These fees are wrapped into one annual percentage expense and make it difficult to determine how much a 401(k) provider is actually charging. Mutual fund companies may offer share classes from “A” to “R” with the only difference being the variable fees charged to investors.

More expensive share classes often pay additional revenue to advisors, brokers and the plan provider.

The American Funds American Balanced mutual fund is a popular investment option in many 401(k) plans. The fund is offered in different share classes ranging from R1 to R6. Below is a breakdown of the range expense charged for the same investment.

American Funds is not breaking any rules or regulations by offering different share classes but it can make uncovering how much compensation is being paid to whom quite challenging.

We often hear business owners and CFO’s claim their 401(k) plan is “free” because they do not see the breakdown of expenses in their respective share class. In the American Funds example, the difference between an R1 and R6 share class is over 1% in annual expenses.

Over longer time periods, even small increases in expenses have a big impact on growth in retirement accounts. The graph below illustrates the impact after 30 years on an account assuming a starting balance $50,000 with $5,000 annual contributions and a 7% return.

The graph is a hypothetical example of how account balances would differ for an investor utilizing R1 vs. R6 share classes.

After 30 years, the R1 share class would have left over $150,000 on the table compared to the least expensive R6 fund option.

This chart illustrates the drastic impact a more expensive share class can have on retirement savers. Over long periods, the higher expenses eat away at returns and may cause investors to delay retirement.

The industry is shifting towards more transparent fees and better disclosures. It makes sense to separate fund management, recordkeeping, third-party administration, and advisory fees to comprehend how much each component costs. The proposed fiduciary rule promotes more transparent fee disclosures and we are big fans.

No 401(k) plan is free. Costs are often baked into the fund expenses making underlying fees invisible to the naked eye.

Fortunately, there are plenty of resources available that allow a 401(k) investor to decipher and breakdown share class expenses.

The Financial Industry Regulatory Authority (FINRA) offers a free tool that breaks down the expenses of any mutual fund share class.